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tv   Book Discussion on The Undercover Economist Strikes Back  CSPAN  February 1, 2014 11:00pm-12:24am EST

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>> as you know, p.j. is a fellow here at cato, here last month talking about his new book, and as it happens, i was amused to see that he was featured in the book as well, and the first
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chapter starts with a quote which i'll read to you in its entirety. this talks about economics specifically wrong and microeconomics talks about things economists a wrorng about generally. jokes aside, i don't think that does justice to the profession. i think in micro, i believe that is well published on which most academics agree, and by the standard of social sciences, a rigorous way of settling this agreement that is some scope for rigorous conclusive agreement,
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and they like to say micro is one true theory with many applications and macro has no true opinions. i think that's a fair assessment. think about basic social relevant policy questions like did the obama stimulus, the agent of 2009 increase employment or not? if not, was it because it was too big or too small? it becomes really remotely resembling the policy question, and so there's always a lot of answers surrounding the answer, notwithstanding the fairly certain claims made by people who sort of know or think they know for sure. the book that discusses today
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does not shy away from these ambiguities surrounding macro, doesn't try to hide them or obscure them, but rare introduction to the subject where they try to explain a rather complicated issue ranging from gdp measurement, problems of minimal adjustment, inequality and so on in a way that's accessible, engaging, funny, does not dumb things down as many dmen at a timers like to do. just a few brief words about the feature speaker, and then we can hand a over to him. a senior columnist with the bbc. his long running column, the undercover economist, discusses the hidden economics of everyday
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life, and the new column, heros, four highly successful books, and the undercover economist was sol over a million copies translated into 30 languages, and he wrote the logic of life, dear undercover economist, a collection of, i think, his newspaper columns, and he's been with bbc radio for his more or less show and his new theory started last year called -- libertarians recognize him as the recipient of the 2006 for economic journalism, also runner up in ten, and several
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locations, journal i'm from growth in a society. it's been published in newspapers and magazines ranging from forption to wired and esquire, was on planned money, and other radio and television programs. he lives in oxford, received his a degree in pp, and he also studied economics in oxford, and visiting fellow. alex is a professor of economics in george mason, and he worked on the range of public economics and lower economics, working on the effectiveness of bounty
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hinters compared # to the police, works on problems in the judicial systems, how elections buy judges, look at poverty rates that affect trial decisions. he looks into the problem of organ transplant and how market mechanisms increase supply of organs available for transplant, and other issues, more specifically how there is a drug regulation. he is author of the marginal revolution, and at the university, and he wrote a series of textbooks of modern principles of economics, one a
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microof textbook, and last year, a year and a half ago, he wrote a book on innovation and long term growth related issues called launching innovations renaissance. he's been published in the "new york times," "wall street journal," scene a number of other precity gas, and he's a fellow at the cato center, so the idea for this afternoon is to have the speakers speak to up to 20-25 minutes and open it up for q q&a and try to conclude session promptly at 1:30 p.m.. now, without any further adieu, i'll turn things over to tim. [applause] >> well, thank you very much. thank you so much. the thing that really anows me
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about the debate is that it's either income presencebly mathematical or dishearteningly political. people don't really seem to be interested in exploring what's going on and discussing it and trying to understand it and understand what makes it tick. they are interested in sound bites and in tribalism. for instance, just this week the statistic gripping the world's papers were put about by oxford, the world's richest 85 people between them controlled more wealth than the poorest 3.5 million people, and the guardian newspaper points out the richest people could fit conferbly on a double decker bus. these guys are never going ton seen on a double decker bus, but, still, i thought about this, and i thought, well, there's all kinds of interesting
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things we could say about wealth inequality and whether it's a problem and what to do about it, but this is not helping. i'll tell you why it's not helping. not only are the richest 85 people in the world controlling more wealth than the poorest half of the world's population, but i know a person who all by himself controls more wealth than the poorest billion in the world. he's my 2-year-old son. he has no debt. therefore his wealth is approximately 0, and since the poorest billion people in the world have negative wealth, my son controls not only more than any of them, but more than all of them put together. if you this is absurd, you're right, it doesn't make sense and neither did the report or a week's worth of newspaper headlines about it. this is just typical of the
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standard of debate about economic issues in general. i wanted to do something a little different with the undercover economist strikes back and talk about a subject that i don't need to make the case that macro economics are important. we've all seen that. the hard way, over the past six or seven years. it's a subject not only important, but interesting with fascinating, flawed without a doubt flawed, but something to offer only if we spare the time and patience to figure out how it all works. leave aside not only the absurd claims, jar begin, but the politics. i'm bored of it, and i suspect you are too. today, i thought to give you a naiver of the book and something to criticize or compliment, i
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tell you a story of the key characters in the book. the story begins just before christmas in 1949 in london, the london school of economics, a seminar room, and the great and good of british economics are in the room, and lionel robins who ran the department for years have been trying to set up a rival. they were recruited, brought in people like james immediate, the great trade theorist who did so much to steer the british economy through the second world war, the great development economist, and hayek, may have heard of him, and really great economists that have been brought in to try to make the cutting edge of economic source, but on this particular day, the person giving the seminar was not a hot shot professor transported over from harvard or
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vienna. it was a mature student from new zeal land, incredibly nervous, giving the seminar with a cigarette, smoking away to calm the nerves because he knew that it depended, his academic future depended on this, and the record was poor, failing all of his exams, and yet somehow, he had been persuaded that this was the man who needed to be invited to give this seminar, and they showed up to hear him speak because there was mew roars he would do something odd, notable, worth discussing, extraordinary, maybe ridiculous, and they wanted to see it, have a laugh, and the man's name was phillips, born 35 years earlier in a rural part of a rural country, new zealand, and his dad, a dairy
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farmer, and the farmer which he grew up was the only one in the area to have lek rick lights, laboratories, not because he was rich, but he was an engineer, a tinkerer, and he liked to solve problems k take things apart and put things together, and he gave that same enthusiasm for tinkering to build teaching him to make his own p toys and radio set, and bill started developing his own inventions, and so the first one, of course, useful as a lot of modern macro economics and built a bicycle stand to gone go on the front of the bike, cycled nine miles, get a train to the nearest town, go to school, get the train back to the station, pick up the bike, nine miles home to the farm.
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this allowed him to put novels and textbooks on the bike cycling. it was not a great success, but pretty soon, he graduated to more successful projects. he did something i think symbolizes something important about bill. he heard for the neighbor, a broken down truck, and everybody in the neighborhood had given up on this thing. it was never going to run again. bill got hold of it, popped open the hood, had a look and said, well, i got to be able to figure out what's wrong here and figure out how this works. that's what he did. he set himself the task of understanding how the engine works, and when it finished how it works, he fixed the truck. he got it going. he was 14 years old, and bill used to drive his friends all the way to school and parked around the corner so teachers didn't see and then drive all the way home.
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that was bill phillips, left school at 15, didn't go to university, and the main reason he didn't go to university was because of his first brush with why economics and the economy is important. the great depression started, started with this seizing up of wall street, and the scrambling fingers were reaching all the way around the world pulling down dairy prices even in new zeal land, and suddenly, they didn't have the money to send him to university. he needed to go get a job instead. first job was a hydroelectric dam, teaching engineering by mail, but he was going to leave, and then at this line in the "wall street journal" review, that says steve is the indiana jones of economics, which is a
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nice line, and i like steve, and i like -- but i don't think it is true or that he's the indiana jones of economics. bill is the indiana jones of economics because in between showing up and leaving, he was setting up an open air sip ma, worked as a gold miner, crocodile hunter, arrested by the japanese, accuse of spying, what you do on a year out, and after riding the transsiberian railway, after all the adventures, ended up at the london school of economics signing up not just for an engineering degree, but also for the british royal air force, immediately, war broke out, and he was sent all the way back across the other side of the world to participate in the defense of singapore, and he was still an engineer, trying to solve problem.
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the first problem he wrestles with was how to get the machine guns from the terrible old plain planes, how to get them lined up with the propellers to fire through without hitting your own plane, not a good idea, and he heard that in europe, the cutting edge planes look worked like this, but the others were well out of date and didn't do this. bill managed to, with limited tools and frightening limited aviation experience, got this working, managed to get the planes firing the way modern planes did. the british surrendered singapore quickly, and bill was on the last refugee ship leaving with civilians b and he was in charge of weapons on board the ship, the japanese found them, dive bombedded the ship, designed to hold cargo and five passengers, but there was 2 #
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,000 women and children on the ship. bill had a machine gun. he didn't have a stand. he disappeared and improvised from tooth paste and snot or something, and put together a stand, came back up, stood on the deck, and single handedly, this heavy machine gun and improvised stand fought out of the japanese air force and later won a medal of bravery for that, but in the end, he ended up in prison camp and the tinkering continued making tiny radios, a radio so small you could fit it in the heel of a clock, and this was is the 1940s, 5 long time before ipads, working with whatever we can find in a prisoner of war camp and he managed to do it. if he was caught, would have been executed. he said it was really important that the prisoners had news of what was going on on the outside world.
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he built dozens of them to make cups of tea, very important, british empire at stake, and made so many, it's every evening the japanese would notice that the lights in the prison camp were dimming, and this is bill phillips drawing electricity to make 2 # ,000 cups of tea. really a remarkable man. the darkest episode was moved in a different camp, didn't know where it was, what was going on, but had a good idea. because the first time they wanted to do, and the machine gun on the walls pointing inwards, and another problem was the clock radio broke. phil and the novelist in the
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camp with him and a third man, came up with a full-proof scheme to fix the radio, and when i tell you about it, h's risk free. they were going to break into the japanese camp commander's office in the middle of the night, take apart his radio, take the part out of the radio, and that looks suspicious so take the faulty part from bill's radio, and install that in the japanese camp commander's radio, reassemble the commander's radio, put it back together, and the genius of this is when the japanese came in and switched the radio on, they realized it was faulty, take it apart, see the component, and order a replacement. this was the gift that kept op giving to do it again and again and again. thinking long term for three men who just dug their own grave. fixed the radio, plugged it in,
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and the first thing that he heard was the news that the americans had dropped the atomic bomb and hiroshima, and the war was about to end. when pee got bang to london school of economic, he didn't want to study engineering anymore, priorities changed, he had taken the mother of all years out, and he switched to cosh yelg, and i apologize if there's any sociologists in the audience, but he didn't think it an important problem, but noticed one thing that faze nitted him.
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and he noticed the equations, and recognized them in the mail engineering course and used them in the flows of water through pipes and overbarriers and through turbines, and it was the same stuff. he went to james mead, doesn't really care, and he went to james immediate, and he said, i got an idea, i want to rework your principles of economic lek democratic lectures as a study in plumbing, and mead said -- by the way, if you are failing your exams, try this with your professors. just a thought.
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he said, okay, off yo go, took the summer off, disappearedded to a carriage, belonged to the landlady, and with a colleague, built a machine that bill was demonstrating, weeks before christmas, 1949, all the greats are there, and bill unvails what looks like an exercise machine for goldfish. you got tanks connected together by pipeses, pump, dams, filled with water, and the water is stained pink to see it clearly, and they got floats in them. the floats are attached to pegs that run through these slots so that as the level of water in a tank rises, the floats move from one side or the other side, and you can carve out a curve literally carve a curve in the side, and the tanks are labeled
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with things such as consumption or government expenditure or taxation, exports, imports, and there's a tank that reads national income. bill reached around the back of the machine, twitched on a fuel pump schav advantaged from a wartime bomber, schav advantaged the machine from a wartime bomber, and fuel pump is wearing away like a prosayser, and it explains what he built is the first computer model of a national economy. the conversation turned to how he can be given a professorship sat the london school of economics. the story about bill, i love, and the story about his machine, although the story has a sad end
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i think. i like the machine because it's not just a good model of the economy, but we can agree an economy is more complicated than a bunch of interconnected fish tanks, but i love the way he tries to show something very important about how an economy works, everything is connected to everything else. you got to see the system as a whole. they already mentioned frederick, the famous essay, what is not seen. we were constantly led astray in economics by reactive forces going on behind the back of our heads as we look at some particular phenomena. bill said, no, i want it in front of you to see everything that matters. see it all flowing together, and that's a very important fact about any successful model. got to have that property of showing the system as a whole working.
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it was a wonderful teaching aid, and bill used to use it to teach economics, and mead plugged two machines together, plugged the exported -- import pipe into the export pipe, and get two students out to the theater and said you're the governor of the bank of england, manipulate rates and see what happens. walked all over the floor, fantastic. one of the students he pulmod out and asked to be chairman of the federal reserve was a tall, young american road scholar by the name of paul volker, who was a good teaching aid. what happened next? to me, it's a shame. ask anyone who did an underdegree in economics about bill, they know nothing about the air force, nothing about the
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metals or the prison camp. they may know about the phillips machine, but they are a quaint, apt kuwaited, who makes a computer made of water these days. we have models that are much more complicated and better, you can't see huh they work. there is one thing people know about bill. bill is the discoverer of the curve, and he observed it with a correlation between inflation and unemployment. that's the gist idea. when inflation is low, unemployment is high. he put together some diagrams. he used draft paper, showed it the colleagues who got veryings
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very excited about it. you got to publish this. very important. he said, well, i don't think so. it's a rushed job. it's just a correlation. his colleagues insisted. the curve became thee most cited journal article in the history of macro economics. paul, the great american economists, picked it up and championed the idea governments could choose a point on the curve, choose high inflation, low unemployment, low inflation high unemployment, your choice. you have to choose, and economists championed that idea. something happened in the late 1960. friedman and phelps, and then shortly after, report lucas published critiques of the curve saying, sure, it's impressive, but it's just a correlation.
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you really have no idea of the underlying behavior driving it, and if you don't understand the behavior driving it, you don't really understand it you can't rely on it. there's a famous example saying it's like trying to prevent people from kicking the ball in american football. i'm not going to explain american football to you guys. i hope you know it better than i do, but, you know, you get foir downs, four attempt, and in the fourth if you haven't got the ball far enough forward, you concede concession. get the ball dun the field. now, let's say the regulatory authorities of the game wish to prevent punting. they don't want people to kick the ball away. well, look, the philips curve says look at the data. the data says don't punt on the
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first or second or third down, but always the fourth. abolish the fourth down. that should fix it. you make completely the wrong policy judgment if you don't understand the incentive. it doesn't matter how good the data looks or how convincing the correlation is, you don't us the surface, you get it wrong, and that's what they said was true about the curve. there was an oil crisis of the 1970s, and the curve style change and macro failed, and the curve itself fell apart, dishearteningly solved into the air. at pa point, something damaging happens to the economics. it started treating data like trust of this person, all these
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years, they seem to be constant, and then with we really needed them they betrayed us. that's how economics started to feel about, you know, facts, don't trust them. they seem useful, but you can't trust them. for a long while, they turned its back on facts and focused on consistency and understand that what is going on under the surface, and sort that problem out, it can't take too long, go back to look at the facts again, and so we're still working on the consistency and having trouble resolving it with facts about the world. economics is starting to turn outward again and very important and useful pieces of work being done, but i think that was a very damaging episode. unless you understand how and why it happened, the rules of
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macro -- why ignore the data? there is a reason. i don't advocate ignoring the data. i think it a mistake. there was a reason. tf not cia crazy. you might wonder to yourself, what about bill? during all of this? well, bill never really defended himself against these, and there's two reasons for it. one was he never believed the sperption of the curve anyway. he always said it's just an interesting correlation, said it was a rush job. there's even some evidence colleagues pushed the paper without his permission on sabbatical to get the profezship for him. there was another reason. by the time the oil shock hit and the curve had just disappeared, bill was dead. had a stroke and dieded young.
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sad not only because it's sad whenever anybody dies before their time, but this was a great man, a praghts call thinker, pragmatic, and yet he's linked with an idea proved to be wrong that he never really believed in. what i feel we need to keep of the spirit was this strange balance that he hadment on the one hand, humble, saying we don't really understand what's going on. it's just a correlation. don't get excited. don't overrate your ability to understand the economy. statement, they were not willing to give up or say it's just too hard. i don't understand it. bill felt about the economy the way he felt about that trust. when he was 14 years old. yeah, everybody else concluded that it's broken down.
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everybody else concluded there's nothing anybody can do to fix it, nothing nobody can do to understand it. i'm going to understand it and fix it. and he did. thank you very much. [applause] >> all right. great. great pleasure to be here today to be talking about tim and tim's book of a long time fan of tim's work, and of this book in particular. that's where i want to begin, just briefly mention things i really like and get into a little bit of a critique. tim, as you can just see, is a genius at story telling, and he is bril lament at presenting complex ideas in a simple way bringing them to life.
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here is how tim explains why rational expectations is important and why we need to model some of the time people as having rational expectations is because not everyone is charlie brown. fool some of the people some of the time, but not everyone. some people, in fact, do learn. some people are charlie brown, and that's why we need behavioral economics as well. tim can be hard hitting when necessary. later, i'm going it say he's soft for my taste on some questions, as the british say a little left, but he's hard hitting when necessary, and this is important because not all of our problems are macro problems,. there are micro problems that we understand very well in which a need to be addressed, and so tim point the out, for example, that in spain, the standard
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employment contract says for every year you work, you get 45 # days severance pay if fired. if you worked for eight years for a firm, you get a year's severance pay. firms never want to fire people. it's too expensive, but because hiring someone has potentially large consequences they never want to hire people, particularly young people who you don't know. as a result, youth unemployment rates, tim points out, hover around 50% in the eurocrisis with no sign of improvement. again, this is a deep microproblem, and it's important to point it out. tim is appropriately skeptical. he has a number of chapters in his book. defending the economics, and he has a very nice chapter
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defending gdp, the statistic, and he's he's talking about happiness, the method of happiness, economics, and so forth. he's also appropriately skeptical of the idea which physicists like to express that we can't have economic growth, and it can want go on forever because there's a limited amount of energy and can't use expo exponentially more energy, and tim has a nice reputation of this, appointmenting out that, yeah, if i'm poor, then it's cold, i need a hat and wear a sweater indoors, and if i get richer, then i'll turn off the heat and take off the hat. this does not mean if i win the lottery i celebrate by boiling
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myself alive, okay? we can get a lot richer and i'm the director of the public choice center, at george mason university, so it's not too surprising, i suppose, that i say there's not enough public choice. p i want to give context to this. strike back is written as a q&a, questions and answers. i think there's sort of two problems with that. not problems for the reader. this is an excellent way of presenting material and flows beautifully and so forth. these are two metaphysical problems. one is do we really know the answers? okay. do we have the answers? you know, the economy is clearly a very complex system, and there are many open questions, frontiers of economics, pushing against, a lot we don't
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understand. the q&a frame work does not always get to that. the second issue is if we know the answers, well, why don't we implement them? tim rice beautifully and well, and you think 24 is easy to understand, why are we implementing this? why not implement the answers? there's two answers to that question. one is the answer that just says people are stupid. actually, i'm a little similar pat koa with this. you know, contrary to belief, my political views and paul's actually don't differ much, just a tiny bit, actually, because, you know, paul says that republicans are evil, stupid, you know, inexe tempt, and if we just change the words from
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republicans to politicians, i would agree. this is small, small tiny change there. it's always pee due lar to me, best, if you think the democrats are angels, and the republicans are nays, you'd think that as long as you understand that, you know, about half the time the knaves are in power, that should make you a libertarian half the time or 50%, but apparently paul doesn't see it that. the second answer to why we know the answers, assuming we both know them, why are they not implemented is the public choice answer. that its incentives and institutions. that there's a reason why politics does not respond in the way in which an engineer like bill philips responds. there's reasons why fixing a
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truck is not the same as fixing the economy because when you fix the truck, there's not people trying to stop sign you from fixing it. there are not people who benefit when the truck disease not work. when you're dealing with an economy, there are people who can benefit, and we need to understand that. what i want to point out is just a few areas in which understanding the limits of politics can change, and what you think of is policy. tim talked about the gold standard in his book, and tim is antigold standard, but only in part of the book, and he gives a standard reason why. standard reasons that prevented tim way says you can't print
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gold. that's a problem. they create money from thin air, and it's like a super power. use it. okay. go with this for a minute. let us suppose that we accept economics here, okay? there's a problem. there's still a problem with it. what about the euro? the european yiewn qon and monetary systems is having exactly the same problem we saw with under the gold standard. they are not using their super powers, going with the argument that they should. they are not using the super bow powers, not expanding the money supply nearly as much as one would think they should going on the standard economics. well, if that's true, then, of course, the gold standard stats to look better. look at the history of the gold standard, it looks good, it
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performs better on inflation standards and as well as on recessions and depression standard. there is a nirvana fallacy here that we may not get the optimum even if we understood it. we may not get it because of the political reasons, and that's important when we are trying 20 choose. now, do i think that we should go back on the gold standard in -- do you think this is a good argument to switch to the gold standard? no, i agree with tim that it's archaic, and clearly bitcoin is the way to go. all right. here's another one. a similar storiment the balanced budget. again, tim says it would be a disaster, and gives the standard reason. you can't do couldn't cyclical similar los. okay. let's go with that. assume that we accept that argument. well, austerity. we're not doing counter cyclical
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stimulus, at least not anywhere near to the extent that you would expect on standard economics, particularly in europe, less so in the united states. particularly in europe. that's not what they are doing. if they are not d if the political system is not going to follow what standard economics rems, then, again, something like a balanced budget amendment actually looks quite a bit better. moreover, it does not consider the fact you can't do the stimulus. this does not consider the unbalanced amendment which is to save, in good time, so that you can spend in bad. sweden, in fact, has a rule which says you have to run a 1% budget surplus over the business cycle. that works out in practice to a balance budget amendment. forcing you to save in good time
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to spend in bad. not all of the arguments against a balanced budget amendment apply to reasonable versions of that kind of institutional rule. okay. more regimely, from my perspective, i thought, oh, conventional, middle of the road, so tim basically argued that most business cycles, demand, wage, price, and not all, but we'll see, not all, but sort of most. i can understand that and see that, but think of the difficulties, which is difficult for mod everyone economics, how long can prices and wages be sticky? keep in mind when we hear the u.s. economy created a hundred
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thousand jobs this month, what that means is more like the u.s. economy created a million jobs this month, 900,000 jobs destroyed. the hundred thousands is a net. this means that even when employment and unemployment stats are flat, there's actually an incredible amount of churn going on in the economy. an incredible turnover in new jobs being created and ole jobs destroyed. that means there's plenty of opportunity to change wages. even if you think that for behavioral reasons you don't want to cut someone's wages because they get upset, get mad when you cut wages. because there's so much turn in jobs, you can over new employees lower wages, and there's plenty of opportunities to do that. same thing is true with prices, look. gasoline stations change prices every day, and we don't somehow
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look at those stations and say, oh, the reason it's expensive is because they change their prices, the menu cost, the cost of price changing is large, and what a shame that gasoline firms do this. no, it's not a big deal to them sat all. why can't other firms change the prices? it does not feel -- the story does not ring true to me. for me, price sticks is like a giant walking along, gets gum on the shoe, and it's a -- falters, you know, takes a step and falters because of the stickiness, because of the gum on the shoes, but it's not something which is going to hold back the economy. if you believe that, it's sort of -- if you want to follow that story, you have to think that it's like being stuck in spider mapp's web, okay?
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you are helpless. can't get out of the web. that is not right to me. i also argue that the real shock kind of story, the real side of the economy, the supply side of the economy, is not given the attention. this is true in the blogs, it's true in the popular economics in general. now, tim talks about this. he analogizes real business cycle theories as a failure of the red cross to deliver supplies to a p.o.w. camp. of course, it's great with the story, bill, a p.o.w. camp, but this is one place where tim's analogy does not work so well because it is mannah from help. it's not right. the p.o.w. camp setting suggested supply shocks are far from the normal situation, not right either.
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you have the alternative analogy or storiment here's the one which tyler and i tell in the principles of economics book. a real shock. they are weather shocks in india. panel a on the left here, what you see in green is the growth rate of the output, gene for growth, and in blue is deviations of rainfall from the average. what you see in a is when the rainfall is above average in india, you get a lot of growth in the output, and when it's below average, you get below average growth. panel b shows because india is a agriculture economy, you see them in the real gdp statistics. correlation is not close, but you see when rainfall shocks are above average, real imrks dp is
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above average. you think about the economies, most of the world's recession and depressions have been shocks, rbc style shocks. now, the criticism here is that it is hard to think of big shocks to technology. the one i just gave you know, the weather, this is a good example, but after the weather, well, you know, what are the other ones, and does the weather apply to a development? weather shocks even in the united states still matter, you know, just because as we've seen recently, just tuesday, the government shut down because of the weather shock and got a positive boost in gdp. after that, it is hard to come up with this. oil shocks maybe. this is why this the rbc
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littleture, dynamics, the search has been for applications and transmission mechanismings. how is it the small shocks are amp foyed throughout the economy to become bigger? how are they transmitted from one part of the economy to the global economy, to the aggregate economy. a lot of the work in the area is very much applicable to whatever model you think of, whether it's an aggregate, a lot of the mechanisms, a lot of modern economics tells us important things. they are important areas, even if you think that the real shock driving it is not the right shock. i want to talk about one of the
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application and transmission mechanism. a new one talked about, and to do that, i just want to set the sage #* stage a tiny bit. you know, in conventional rvc models, there's one model is to the economy's output is y, equal to a technology factor a, times a function of capital and labor. why one sector? that doesn't seem realistic. the argument has been that we're interested in asmghting the economy, and this requires an aggregate shock, that is if you think about the sectors than the argument was that shocks to the sectors cancel out. you have one positive shock here, a negative shock here, and
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a blot of large numbers, overall the shocks are beginning to cancel out. if you need a shock to drive the economy, you may as well use the one sector model of the economy because sectors themselves and shocks in those sectors net out in the long run, or when you take them over many seconds. i think this is not correct, where some of the new research comes in. i'll give two responses. one is that large firms are larger than you they they are. this is worked from xavier pointing out that the top 50 firms, for the united states, their sales, as a fraction of gdp is, like, 25%. 50 firms, you got 25% of gdp in terms of fail. when you have so many large firms, the shocks even firm
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shocks make a difference in the economy. 35% of sales. that is one counter that can matterment another one is from darn and coauthors is to start thinking about the economy for a network. it's right taking panel a here, if they sell to itself, the shocks cancel. it turns out to be true in panel b that if each sector sells an equal amount, to every other sector, then the sector shocks cancel. if, however, some sectors sell to many sectors, they don't cancel. in fact, when you look at the u.s. economy, you can see there's at least three or four sectors here that sell to many, many other sectors.
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manufacturing sells to many other sectors. the financial sector sells to many other sectors. you get something wrong in a financial system that will spread throughout the entire economy, throughout the entire network. okay. so do i think that these are, you know, this is the answer? that we've got it? no, not necessarily, but i want to make a few conclusions. first, economics is a growing vibrant discipline with a multitude of approaches. you know, paul has said that, you know, a huge amount of research done in the last 30 years has been a dark ages. i think that's totally wrong and up fair. there are many, many very smart, very dedicated, very budget people ma crow economists who are working on these problems
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who take problems seriously, who are not blindfolded, who understand all the issues, and to infuse them of being dark age economists, i think, is -- does a disservice to the economics profession. the economy is complex. there are a lot more questions then there are answers, and that's unfortunately, but it is going to be true. public choice is important and understanding the limits of poll sicks can help us to choose optimum policies that will be different when we recognize the constraints of politics. finally, buy tim's book. read tim's book. it's an excellent book. thank you very much. [applause]
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>> before we open it up, give them a chance to defend himself, at least three points that were raised that were interestingment one is public choice. the other is nominal stickiness, and the other is real business cycle theory. >> sure, defend myself against the notion that everyone should buy the book, so -- which i agree with, thank you, alex. a lot of aleck's comments were fair, public choice it is important. i wrote about it a fair bit in the book, "logic of life," a great book to buy, and i didn't want to talk too much, but it's very important. on the subject of using the q&a format, i hope that that enailed me to explore some of the complexities, and inevitably, you don't want to, in answer to every question go, nobody knows, it's complicated, there's a multiplicity of views, although nobody knows, it is complicated,
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and every now and then, you have to come up and say, well, i personally, if i had to make a bet, this is what i think. i do occasionally come off the fence, but what i end joyed about the q&a is that it gives the reader a voice and imagines the reader thinking, seeing some piece of macro going, that does not make sense, that's insane, and actually able to say, i don't buy that, and then i can acknowledge that and agree with that, whatever. let me talk a little bit about real business cycles in the prier of war camp. what alex did not give is i trust the prisoner of war camp with another toy recession, which is the recession that's famous, used a lot in the paul's book, took place in the late 1970s two miles that way. it is a recession that happened because of the extreme price stickiness. people were exchanging little
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units of currency in exchange for babysitting time, and they didn't have enough of the currency, and nobodimented to go out and enjoy themselves, but babysit for somebody else until they had more currency, and because they wanted to stay and baby sit, nobody went out, there was a depression, and the depression was effectively permanent because the price stickiness was perm feint. no one would renegotiate on the currency, and the depression was temporarily stalled by quantitative easing, and they overdid it and hiked inflation. what do you know? now, is that a fair model of how a real economy works? no, i don't think it is. people criticize paul sometimes for using it an as example, and that's unfair. he's just trying to give you a sense of some of the mechanisms that might be at work. well, acknowledging a clear economy is hr complicated.
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i wanted to stand up for real business cycle theory giving real business cycle theory another toy model that, dwen, doesn't fully represent the complexity of the world, is in the a great description of a real economy, but it is a system where you see everything working, figure out how the pieces are put together, and that is a prisoner of war. ..
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he said this is crazy the prices keep moving. that can be allowed and there's a just price and try to legislate but the prices kept moving, refusing to reflect any ethical theory and regrettably sticking to the forces of supply and demand. but nevertheless everybody in that camp came close to starving to death because in the end having a good supply was appropriate but there wasn't enough coming in as the war progressed. now is that a fair reflection of real business cycle theory? i think its about as fair as the keynesian theory. the kitchen a sense of what's going on. in the book i talk about more convincing examples of shocks in terms of. shocks. oil shocks and shocks in the financial sector. you may have noticed one or two of them in the last few years and so i felt i wasn't giving it the crack of the whip.
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i was trying to. maybe i failed. just on the point of me being a middle-of-the-road keynesian, well actually i do say in the book that government, fiscal stimulus is almost always inappropriate as a response to a recession. it's almost always going to be unnecessary. it's going to be too late and i believe kaine also agreed with this so i think maybe that does make me a keynesian. whereas elites right to be suspicious of people who propose government spending through demand because they waste money and it's not a great idea. i do say however that i do happen to think that in the most recent recession aggregate demand was an important part of the story when the recession was very deep and there was an appropriate role for stimulus. i also think that's about the first time that has been sure for 40 years possibly the first time that has been true for 80 years. the only thing that makes me to
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keynesian for alex's taste and i would be guilty as charged but thank you alex for the very thoughtful comments. one more thing. stickiness. all i would say is as you describe with supply shocks sometimes and i totally agree sometimes a small supply shock can have a big federal effect. sometimes it can propagate. we don't really understand this very well. i think the intuitions are trying to look at individual firms i think that's a very good approach carried i would just say i feel both with the small aggregate supply shocks and with price stickiness there are fictions. there are little things and they are small and they complicate the models. it's always a bit annoying to have to deal with it in physicist try to avoid it. if you go outside and try to walk without friction you will find out it turns out to be
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important and i can see alex agrees with me when it comes to modeling supply shocks and the same is true with price stickiness as well. >> i think we can open it up or questions so please raise your hands, wait for the microphone and introduce yourself. there's a gentleman in the third row. >> there seems to be a growing number of economists that think that the reason why economists are not very good at predicting things is that they are using their own model and thinking in 18th century terms as the economy is a machine as your good friend mr. phillips did. there's a growing number that think that we need to go back to classical and scholastic economics that has a more complete understanding of human nature and therefore would be reflected in the economy.
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philip law has been a proponent of that and there are people here. what do you think of that school of thought incorporated introduced to the economic modeling being done now? >> i'm a pluralist as i point out in the final chapter. i think a lot of very interesting approaches that need to be reflected in our understanding of the economy and ultimately the economy is a human system and humans are individually hugely complicated and then when you get them together they are even more complicated so approach from sosa -- psychology and engineering understanding banking safety engineering is important not the hydraulic engineering but thinking about whistleblowers. i'm definitely a pluralist and i agree with alex. it's actually very exciting time to be an economist because there's so much data coming in so many different promising
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approaches and interesting problems. what i would say though is that i don't think that's the reason why we cannot or cast and the reason we can't forecast is because forecasting is the present level of human understanding just impossible in all sorts of fields. there's a wonderful study by the psychologist ted locke historian sociologists etc. demonstrating a total failure to forecast because the world is a complicated place. there's a lovely story about keynesian. you had a man with a lot of insight and knowledge and man with a fantastic grasp of british economic statistics because he was building them at the time and he was responsible for currency for the british government during the first world war so how could you be more plugged in? he adopted the trading strategy based on forecasting the business cycle that totally failed, underperformed in the market and switch to warren
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buffett style investment and turned out to be very successful for him. if a guy that will plugged in with logistics and that much insight he got a phonecall telling him that the bank of england was about to change its base rates in a still couldn't make money. the forecasting was very hard and i don't think that should be the benchmark of whether we understand the system or not. >> let me understand of view of the things that tim set which i re-with. first one area in which economists -- [inaudible] especially in macroeconomics there had was a feeling that there was only one week to do it. microfoundations and so forth. even if you think those are good things the idea that this is the only way, the only appropriate way to model the economy and the only thing you can get published in the only thing you can get in the journals, that i think was really terrible. so i agree entirely on that. on which way to go, i think
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that's much less clear. there's a lot of talk about economics and psychology versus the irrational standard of econ. maybe that will turn out to be fruitful. i would say that i think this complexity itself modeling as i was suggesting a little bit the network structure of the economy, the way that sectors and firms are connected, just that alone even without adding in behavioral complications i think will generate considerable amount of complexity. this is not -- you don't necessarily need behavioral approaches in order to have a quite different looking economics. and then on forecasting i agree with tim. you just have to bear in mind that when you are forecasting in economics you are forecasting the behavior of people who themselves are forecasting and
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you are trying to forecast people whose forecasts are they at least as good if not better than your own. those people that are trying to forecast knowing that the policymakers themselves are forecasting so even if everybody was good at forecasting the fact that they are trying to forecast other people that are trying to forecast well then all bets are off and you're not going to get a system which is easily forecast the full and that is the rational expectation of the approach. even if you don't go with rational expectations just understanding the self-referential aspect of forecasting in an economy can tell you it's never going to be very successful. >> hi. i am a retired economist and an attorney. you mentioned lionel robbins was somewhat of a friend and we are
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in the cato institute. i'm wondering as part of your pluralism, in the book you discuss austrian business cycle theory and if so, in a sentence or two what do you think about it and what do you say about it? >> as a pluralist it's a shame i did not discuss the theory. i do talk about hayek a great deal in an earlier book called adapt which is about crises in economies and why they are important and what stands in their way and hayek is something of a hero in their so i will let alex give a good account of the austrian business cycle theory because he is the expert on this but if you want to find out where i think hayek was particularly exciting my early book adapters the one to read.
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>> yeah, it's interesting there are a lot of people who might call foul weather austrians when the economy looks bad they are turning to austrians. call -- paul krugman is famous for having a critique about austrian economics during the good times but during the bad times suddenly there is a lot of things he says that sound an awful lot like austrian economics like the financial system being over expansion on, expansionary. it in the standard australian review have a simple mechanism. it's the government, the federal reserve lowering interest rates and that's the expansionary aspect which then later on this suspension proves to be infeasible in the real set your, just infeasible. now there is a lot of other ways you can tell a very similar story such as the financial system itself, not necessarily
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because the government is pushing supply that through new technologies and new innovations through ceos and new financial innovations. it starts to put out a lot more credit on the basis of the same money supply. you have vast expansion in credit and you get all this housebuilding and so forth and that can later turn out to be infeasible. the public doesn't really want all those houses and to get these collapses and things like that. paul has talked about this, larry summers has talked about this and it's not formalized anywhere but i do think that connecting the financial system with an austrian approach i think there is something there and it is amazing how whenever you have a recession like this people return to these ideas. so the jury is still out but i
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definitely think there is something to that. >> my name is terrence herd and i'm unaffiliated. my questions about income inequality. we are hearing a great deal about it nowadays not the least because president obama and hope francis have expressed great concern about it and mostly those with the idea that unguided free enterprise economic development is worsening the problem. could you comment on the current attention to income inequality, both of you please? >> i'm not surprised that a great deal of attention is being paid to it because it is clearly quite shocking the increase particularly in --
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economies and all the way down the income spectrum but particularly at the top. there's a concentration of income from high earners. now, what concerns me, i don't think it's terribly helpful to say it's the free market. what concerns me is that social mobility is low and as much as we can mention it it's hard to mention is low in 95 countries. i would expect the opposite because these are economies that are more pro-market and more pro-limited and also you might hope that they would be even more pro-limiting than they are but you would think that is the place where there is quality of opportunity and people can rise to the top and there may be extreme inequality but wait another generation and things will change.
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that seems to be less true in america that it is almost anywhere else and it's not really true in canada and not sure in my own country in the u.k.. it's more true in places such as sweden and denmark and that's the puzzle. it's that the concerns me that the income inequality by itself but the lack of social mobility. that suggests there is really up rob him with this idea that i'm sure everyone espouses equality of opportunity and what to do about that i don't know. i don't see tentatively redistributed taxation is being a productive way of dealing with it. i don't see how it's about americans. there is something else being passed down between generations but i will observe that the scandinavian countries have by most measures absolutely first-class primary and secondary education. not only is the average level very high by measures that i
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trust that the dispersion of the quality of schools is low so it doesn't matter what school your child goes to her what to stricter child is educated and they are going to get a good education. i don't think we believe that is true of this city and i don't believe it's that's true in many cases in america and i don't leave its true in my own country the u.k.. maybe that's the place where we should be looking to tackle this issue. >> i agree with much of what was said that let me put things a little bit differently. we always talk about income inequality. the way i would talk about it is earnings inequality. weiss is some are unable to earn much more than other people? i think a lot of this has to do with changes in technology. i think to the extent that the u.s. is different from other
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places in the world i think that is just because we are on the leading edge. i think other places in the world would follow a long and indeed have been following along. what do i mean by technology? the story i think of as jk rowland -- j.k. rowling. she's the first author in the world to earn a billion dollars from her writing. why is this? is this because j.k. rowling was so much a better author than tolkien was for than shakespeare was? no, don't think so. not to cast aspersions on j.k. rowling and i think she's a good author but is she so much better? no. i think the reason is she is able to leverage using technology through her writings much more than shakespeare was. shakes for -- shakespeare 500 people might see one of his plays. rowling has access to basically every reader in the entire world
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not just in english. j.k. rowling is huge in china and j.k. rowling is huge in india. j.k. rowling has access to the movies, to the toys and the tie-ins with mcdonald's and soap worth. when you combine this with the fact that we have a winner-take-all market in the sense that we are not going to read every good book, there's only a limited number of times to read books that we all like to read everybody else's reading. some people partly due to skill and partly due to luck are going to be on the cutting-edge. they will be the ones chosen because with leverage they will have massive earnings. i think this technological factor winner-take-all markets close the technology factor of leverage being able to communicate of having a much larger market globalization a much larger market than has ever been possible.
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this is what explains a lot of earnings inequality especially at the 1%, especially the very top. i don't see those trends going away at all. in fact if anything i see them accelerating. it's unclear what we can or should do about that. i would start with the idea not of income inequality is earnings inequality and ask why is it that so many people are now able to earn so much more than other people? that is my approach to that question. >> one final question. >> michael lenders. i wanted to get your opinions on the idea that income inequality or lack of social mobility may be a function more of disadvantaged groups being taught that they are victims, not responsible for their own life as opposed to pure economic
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factors. >> that's something that i would be interested to see tested and i know that there is interesting work done by a psychologist on the effect of the different kinds of feedback. i don't have any strong view on it and i'm not aware of any good evidence on that but i think as a general principle something alex said really close to the beginning of his talk that a lot of our problems are microeconomic robinson not macroeconomic problems. it's taking place on a scale that we can understand and that's true in the unemployment benefit office. i discuss an example in the book of u.k. and employmenemploymen t
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benefits. the traditional system is money is paid to people who are unemployed but maybe there are welfare -- so they are quiz to make sure that they are absolutely looking for work and not just scrounging. that was the old approach so the new approach was maybe instead of quizzing them to make sure they applied for work last week we should give them advice to help for a play for work next week. bottom floor top floor of the two-story unemployment benefit office. the people on the top floor were using a new method and the people on the bottom floor were using the old method and it turns out the new method was dramatically more effective it having people off welfare and into jobs. you can roll it out in every unemployment benefit office in the country. we need to be doing that more in our schools. we are not interested in that in
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our schools. we have to understand what it is that's going on in the canadian schools that seems to make them so good. really going out there and testt back and see what works in the american context and the british context in what doesn't. sometimes problems seem to be very diffuse and very large indeed actually will submit to microscale efforts based on policy which we need to use. >> this was fun but i'm afraid we have to close so feel free to join us for a nice lunch and join me in thanking alexander tabarrok and tim harford. [applause] [inaudible conversations]
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